Notes on the Week Ahead
David Kelly
Chief Market Strategist
JPMorgan Funds
August 2nd, 2010

The American Consumer: Willing and Able to Spend?

Last week's GDP report provided a balanced dose of good and bad news.  The recession of 2008-2009 now looks even deeper with a 4.1% drop in output from peak to trough, compared to an originally estimated 3.8% decline.

Over the past year the economy has embarked on a clear, albeit tepid recovery, growing by 3.2%. Businesses have done their part - at least in terms of spending - with gains in inventory investment and business equipment spending accounting for almost 90% of the GDP growth in the recovery so far.

However, as the recovery moves into its second year, it is clear that households will need to contribute more to the recovery going forward.  Most notably, both auto sales and housing starts remain at extremely low levels for an economy supposedly on the mend.

So are consumers ready, willing and able to do their part?  On the "able" side of the question, the answer appears to be "yes".  In the years since the end of the housing bubble, consumers have postponed big-ticket purchases and paid down debt, while a relentlessly easy monetary policy has facilitated a steady wave of mortgage refinancing. Meanwhile, revised government data show that disposable income has been growing at a moderate pace over the past nine months.

All of this, taken together, has allowed the personal savings rate to rise from 1.8% less than three years ago to 6.2% in the second quarter of this year, the highest savings rate seen in seventeen years.  With some improvement in stock market wealth, some increase in employment, and pent-up demand for both housing and autos, households ought to be able to contribute more to the second year of this recovery than the first.

The question is "will they?"

Numbers due out this week should shed some light on this question.  Tuesday's numbers on both light vehicle sales and pending home sales should show some increase from recently dismal levels, while Thursday's numbers on chain-store activity should give a broader sense of consumer activity.

Numbers from the business sector may be less encouraging with small declines likely in the ISM surveys of both manufacturing and service sector activity in July. However, the tie-breaker, as is usually the case in the first week of the month, will be Friday's Jobs Report.  Temporary census hiring will again distort the headline numbers.  However, beneath this, the economy should have experienced some continued gains in both private sector jobs and wages in June.

For markets, all these economic numbers will be supplemented by roughly 100 new earnings reports from S&P 500 companies.  So far, with almost 75% of market cap reporting, the majority of companies have beaten on both earnings and revenues.  It now appears that S&P500 operating earnings will end above $20.75 for the quarter, up more than 50% from a year ago.  If the expansion continues, earnings should hit an all-time high before the end of 2011, a scenario which should be positive for stocks and negative for Treasuries.

This in turn depends on whether consumers, who clearly are able, are also willing to drive the economy forward.